If I just straight out told you that there is a model within the conventional economic theory that implies most of us would prefer a world in which we would not be acting humans, you would probably tell me that I have a few screws loose. To avoid this potential label, I will develop this argument step by step. First, let us see what it means to be an acting individual.
Do we act?
Humans act. This statement is irrefutably true because the act of refutation itself implies an end â€“ to refute the statement that humans act.[ref]However, the fact that one cannot refute the action axiom does not mean that it is impossible that humans do not act. In other words, the qualifier irrefutably is crucial here. It just means that it is impossible to reach the conclusion that humans do not act by refutation of the statement â€“ humans act. But, this does not mean that the truthfulness of the action axiom is in some way inferior to the truthfulness of other claims we consider true. For example, most of our formulations of the laws of physics are considered true because there is a high degree of statistical correlation between what we observe and what we believe our formulation would imply. However, no one can claim with certainty that this is the absolute truth. Similarly, each of us observes his or her actions using consciousness. Probably all people you have talked to would tell you that their self-observations indicate that they use means to achieve ends. By doing so, they strive for a more preferred future. In this sense, we base our belief in the truthfulness of our action on this internal observation of reason.[/ref]
But, suppose that what humans do is not action â€“ employment of means to achieve ends. Then it must be something else. What else could it be? Even though we cannot say this with absolute certainty, we might say that non-living matter does not act.[ref]We do not know whether plants and animals act but we tend to assume they donâ€™t.[/ref] Thus, we might say, if humans do not act, then they could be compared to non-living matter.
However, if we assume that humans donâ€™t act, that simply means that humans do not make choices. They do not substitute less preferred state of nature for a more preferred one by using means available to them. In other words, they do not displace one possible future by acting to achieve another, more preferred future. In that case, humans just follow the inevitable path set out for them outside of their consciousness, just like the rocks and stones around us do (at least in our view).[ref]Even writing this article would then be just like a stone rolling down the hill â€“ inevitable and predetermined. In that case, my thinking that I am trying to achieve a different world compared to the one that would exist if I didnâ€™t write the article would be like a stone thinking it is making a choice to roll down the hill.[/ref] [ref]Then, even the statement â€œIf we assume, then …â€ makes no logical sense whatsoever because it is not up to us whether we will assume something or not. Like a stone does not decide whether it will roll down the hill, non-acting humans could not decide whether to assume something or not.[/ref]
Consequently, our attempt to refute the action axiom was not actually action â€“ it was an illusion of action. While we can not exclude the possibility that all of us live in an illusion that we actually make choices, when we do not, we do not know whether we do in fact live in such an illusion. As Ludwig von Mises says:
We may or may not believe that the natural sciences will succeed one day in explaining the production of definite ideas, judgments of value, and actions in the same way in which they explain the production of a chemical compound as the necessary and unavoidable outcome of a certain combination of elements.[ref]Mises, Ludwig von. 1949. Human Action, San Francisco: Fox and Wilkes (1996), p. 18.[/ref]
Thus, it is possible that what we perceive as our choice may be just an inevitable outcome of a chemical reaction, which was in turn an inevitable outcome of some other physical process. However, accepting this as true would be pure speculation. What we do know is that our self-observation does indicate that we do indeed make choices â€“ that we act.
The World of Action
Human action is impossible in the world of complete information. In this world everyone knows everything there is to know, including the future. Thus, one cannot act if he or she already knows his or her future. There is no space for choice in these circumstances.
It is hard to make definite statements about preferences of all human beings but we could safely state that many humans would be terrified to live in a world of complete information. In other words, many of us, if not all, would prefer a world in which we can make choices, a world in which we can use means to change our life according to our desires, a world in which we can act. Thus, it seems, at least given the general sentiment of human beings, that they prefer a world in which action is not an illusion, a world in which we are indeed different from stones that roll down a hill governed by nothing more but the law of gravity.
Now we come to an important point: If humans really prefer to be humans in the way we perceive ourselves â€“ as acting individuals, then the probabilistic concept of risk-aversion is contrary to the nature of human preferences toward action.
The World of Probabilistic Risk-Aversion
The probabilistic concept of risk can be represented by a situation when an individual (let us call him Jim) faces different future paths that offer different payoff. It is assumed he knows the probability distributions (or probability density functions) of these future events.[ref] Note that the Frank Knight’s concept of uncertainty when an individual does not know all the possible outcomes and thus does not know the probability distribution of the future events is assumed away within this framework.[/ref] What he does not know though is which path of all the possible paths the future would bring.
This situation is often illustrated using flip of a coin. Suppose Jim is offered a game in which a flip of a coin determines the amount of money he will receive. If the coin turns heads, Jim receives, say $100. If, however, the coin shows tails, the he receives only $50. Alternatively, he may be offered $75 dollars straight out without flipping any coins.
The next step is to qualify Jimâ€™s risk preferences. If he chooses to flip the coin, he would be qualified as risk-loving. If, on the other hand, he chooses the certain $75 dollars, he would be qualified as risk-averse.
This risk-aversion qualification is associated with the fact that Jim refused the so-called â€œfair gambleâ€ where the expected payoff of getting a $50 and a $100 with equal probabilities (1/2) is $75. In other words, the expected outcome of the gamble is $75.[ref] Note that $75 is not in the set of possible outcomes. Thus, the term expected value is a somewhat awkward choice for the payoff of $75 in a single flip of a coin. The statistically correct interpretation would be that if this flip was repeated many times, the Jimâ€™s expected payoff would be $75 per flip because he would, on average, get an equal number of heads and tails. In a more sophisticated probabilistic approach, it is assumed that there is an infinite number of possible outcomes, all described by a smooth probability density function (PDF). In this case, the expected (i.e., average) outcome is within the set of possible outcomes.[/ref] Thus, Jimâ€™s choice is interpreted as an aversion towards the risky nature of the gamble since that is the only difference between a certain $75 and a â€œriskyâ€ expected $75.
Whitin the probabilistic framework, this means that if Jim, who is risk-averse, knows the probability distribution of different future events â€“ getting $100 and getting $50, he would prefer a world in which he would get the amount of money half way between $50 and $100 with absolute certainty. If he had an option to choose between these two worlds, he would choose the world of the-middle-of-the-road certainty instead of the world where he could possibly end up in a better situation than the-middle-of-the-road but he could also end up in a worse position. It is said that he would trade off the possibility of potential $25 gain over the average $75 for the absolute certainty of $75.
The bulk of economic literature states that most people would choose the option in which they receive $75 with absolute certainty. In other words, most people are qualified as risk-averse. This means that most people would prefer to get the expected, middle-of-the-road outcome with certainty rather than face an uncertain future where they could get much more but also much less than in the world of absolute certainty.
If we generalize further and assume that Jim knows the probability distributions (or probability density functions) of all future events in his life, using the logic of the probabilistic representation of risk, one could conclude that Jim would prefer a world in which he would live his expected, middle-of-the-road life path with absolute certainty over an uncertain world.
On the surface, this does not seem too strange. Many of us would probably like an â€œaverageâ€ life, without too many frustrating perturbations. But, the above conclusion is not about preferences about life in an intrinsically uncertain world. It is a statement about preferences between an intrinsically uncertain world and an intrinsically certain world.
But, if one knows his or her future, where is the logical basis for purposeful human action? Is it really true that most of us would prefer not to act? I would say that this is not true. Rather, the probabilistic concept of risk-aversion does not have the robustness of a general theory. In other words, this concept seems sensible in isolated cases but when applied as a general principle, it contradicts the nature of human existence.
Averting Uncertainty through Action
On the other hand, members of what some call the Austrian school offer a more robust, qualitative[ref]Some economists would probably say that the lack of statements that imply strict quantitatively measurable characteristics of individuals that could be assessed using statistical techniques is an indication of a lack of robustness. However, if one takes the view that every individual is an acting entity with individual-specific characteristics, any statistical analysis that uses controlling class variables to explain individual action would end up with zero degrees of freedom (i.e., impossibility of statistical estimation).[/ref] understanding of risk. For example, Murray Rothbard makes a clear distinction between gabling and entrepreneurial risk-taking:
Gambling on the throw of the dice and betting on horse races are examples of the deliberate creation by the bettor or gambler of new uncertainties which otherwise would not have existed. The entrepreneur, on the other hand, is not creating uncertainties for the fun of it. On the contrary, he tries to reduce them as much as possible. The uncertainties he confronts are already inherent in the market situation, indeed in the nature of human action; someone must deal with them, and he is the most skilled or willing candidate. In the same way, an operator of a gambling establishment or of a race track is not creating new risks; he is an entrepreneur trying to judge the situation on the market, and neither a gambler nor a bettor.[ref]Rothbard, Murray. N. 2009. Man Economy and State with Power and Market, Auburn: Ludwig von Mises Institute, p. 555.[/ref]
Thus, an entrepreneur does not â€œconsumeâ€ risk for the sake of it. He faces the unavoidable risks that are inherent to the market process in order to earn profit. All of us are, in one way or another, trying to reduce the uncertainty inherent in the world around us by using the means available to us â€“ by acting. In this sense we are action-loving and this action-lovingness comes from our aversion to an uncertain future. We act in different ways to achieve different kinds of more certain future.
For example, this article was written for the purpose of making the future in which people understand the epistemological limitations of the probabilistic concept of risk-aversion more certain. But it would be a mistake to conclude that this means that I would prefer a world in which I would know with absolute certainty that I will write this article and the inevitable future events this would leed to. This is an error that results from extending the probabilistic concept of risk-aversion into the context of human action.